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New Anonymity Rules in South Korea Are a Big Blow to This Cryptocurrency Movement

Hint: Bitcoin investors aren't the real losers here.

Investors are often waiting for the "next big thing" to come along -- and in 2017, it was the emergence of cryptocurrencies. As a whole, the combined value of all digital currencies went parabolic, with a better than 3,300% increase in aggregate market cap between the beginning and end of 2017.

Since day one, bitcoin has been the captain of the cryptocurrency ship. It's the largest virtual currency by market cap, and is easily the virtual coin most accepted by merchants around the globe. Bitcoin is also responsible for putting the spotlight on blockchain technology. Think of blockchain as the infrastructure underpinning digital currencies that's responsible for logging all transactions without the need for a financial intermediary.

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Investors are clearly excited about the potential advantages blockchain brings to the table in the financial services industry, and they're intrigued about the idea of using digital currencies in place of traditional paper currencies to purchase goods and services. Signing up merchants to accept this digital money is exactly what bitcoin and Litecoin have focused on.

But not everyone is a fan of the crypto craze. Around a half-dozen countries worldwide have banned bitcoin, or cryptocurrencies, in general. The countries that have done so typically believe it's a potential source of fraud and money laundering.

Of course, there's also a handful of countries that haven't exactly banned bitcoin or cryptocurrencies, but have nevertheless laid down pretty stringent rules regarding the trading, mining, or ownership of digital currencies. China, for example, closed the door on initial coin offerings, shut down domestic cryptocurrency exchanges, and throttled electricity to bitcoin mining operations since summer.

South Korea rattles the crypto market with new regulations

More recently, we've witnessed South Korea stepping up its regulations, as well. This is of particular importance, as the South Korean won was the second most-used currency, behind the U.S. dollar, in global bitcoin trading in 2017. It's also the second most-used currency for trading in Ethereum and Bitcoin Cash. In other words, changes in the South Korean regulatory environment for cryptocurrencies can have wide-reaching effects on the market.

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Earlier this week, South Korea's finance regulators announced that they'd be further expanding measures designed to identify cryptocurrency traders so as to reduce the potential for fraud and money laundering. Beginning Jan. 30, only individuals with verified bank accounts linked to cryptocurrency exchanges will be able to add new funds into virtual currencies, according to The Wall Street Journal. Investors who already have money in cryptocurrencies and cash out will be able to move that money back without issue, but injecting any additional funds beyond Jan. 30 will require a major step-up in transparency.

This move also puts added pressure on banks within South Korea, which will be responsible for detecting money-laundering activities. Banks will be barred from dealing with cryptocurrency exchanges that fail to disclose the identities of their customers, with foreigners and minors banned from cryptocurrency trading, too.

This new cryptocurrency movement could take it on the chin, thanks to South Korea

This step-up in regulations clearly has the crypto market on edge, with the bulk of bitcoin's recent volatility and lost value derived from actions and rumors coming out of South Korea.

The concern here is simple: Cryptocurrency investors and enthusiasts really like the concept of anonymity. Not having to provide a bank account, Social Security number, or even name, in some instances, to open an account at a decentralized crypto exchange, is a big reason why libertarians flocked to bitcoin and a handful of other alternative coins in the first place. Removing this is viewed by some as taking away the biggest dangling carrot of cryptocurrencies.

Image source: Getty Images.

However, truth be told, cryptocurrencies like bitcoin are nowhere near as anonymous as you've been led to believe. Though bitcoin transactions are encrypted, a blockchain analysis can often allow regulators to trace a payment back to a sender and/or receiver. The vast majority of cryptocurrencies are this way, whether you realize it or not.

The one movement that could find itself damaged far worse by increased anonymity regulations are privacy coins, such as Monero and Dash. Monero takes the expected anonymity associated with cryptocurrency transactions and turns it up a notch, such that the sender and receiver of funds is obfuscated. It does this by using ring signatures, which is akin to a joint checking account with multiple signers -- although you'll never know who actually sent a payment. There'll also be a stealth address, to completely mask the sender, receiver, and the amount sent.

Privacy coins could be the real target of South Korean regulators, as they're the obvious digital-currency choice of criminals, since they can't be traced. Though privacy-coin operators suggest that the number of illegitimate users is relatively small next to legitimate users, the privacy-coin movement stands to lose more than bitcoin and other digital currencies if more cryptocurrency hotbeds beef up their anonymity regulations.

This is a trend that privacy coin owners will need to a keep a close eye on.

Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool has a disclosure policy.

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A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and investment planning. You'll often find him writing about Obamacare, marijuana, drug and device development, Social Security, taxes, retirement issues and general macroeconomic topics of interest. Follow @TMFUltraLong